— This is the script of CNBC's news report for China's CCTV on June 20, 2019, Thursday.
The fed's statement overnight, followed by a speech of fed chairman Powell, unsurprisingly hinted at a dovish shift in the fed's overall monetary policy. In the latest statement, the most important changes in wording include: The fed deleted the long-used phrase "being patient" from its policy statement. The immediate message to the markets is that the fed is signaling a rate cut.
Diane Swonk
Grant Thornton Chief Economist
So they are putting together a combination of factors to do this sort of preemptive cut in terms of a recession to an inverted recession and also extend the expansion. That really is explicit in their statement. Now that wasn't one of their goals in the past to sort of sustain the expansion, but that is in the statement now and it's something that chairman Powell has really emphasized since beginning of the year.
However, while the overall trend is dovish, there is an unusual divergence between the fed and the market on the path of future rate cuts. Let's start with the expected guidance from the Federal Reserve.
What we usually look at is this dot plot that the fed released after the meeting, each point represents the expectation of every fed official about the future direction of interest rates. The latest chart shows that while eight fed officials now expect a rate cut within the year, most do not expect a rate cut before the end of the year. For next year, most fed officials are now inclined to cut rates once.
So that's the attitude of the fed, although it shows that the fed is divided, But for the overall rate cut and timetable, is still very cautious. The market, however, is offering the opposite.
Let's look at CME federal-funds futures, which generally reflect the market's probability of interest rate moves. The odds of the fed not cutting rates in July are now zero. That suggests the market thinks the fed's rate cut next month is a foregone conclusion. The only difference is the size of the cut. There is a more than 70 percent chance that the fed will cut rates by 25 basis points in July, and a closer 30 percent chance that the fed will be more aggressive and cut rates by 50 basis points.
Take a look at market forecasts for interest rates at the end of the year, the odds are close to 70% that the fed will cut rates by at 75 basis points this year, if it cuts rates by 25 basis points at a time, then that means the market is pricing in at least three rate cuts this year, with a more than 20% chance of four rate cuts.
Some analysts believe the fed was cautious at its June meeting because of two major uncertainties between the June and July meetings. Fed officials want to see more data, including the development of the U.S.-china trade talks at the G20 summit, and the U.S. employment data, if global trade frictions don't improve, and if we see bad employment data, then maybe the fed will act in July. At the moment, expectations of rate cuts are a big driver of market sentiment. We saw all three major U.S. stock indexes edging up overnight, while the dollar fell after the fed meeting, with the dollar index down 0.5 percent. That has sent dollar-denominated commodities such as gold and crude oil soaring
Gold climbed above $1,386 an ounce this morning, London Brent and US WTI futures both rose more than 1.6 per cent this morning.
But there are also warnings that the positive sentiment in the markets based on the fed's rate cut could be very dangerous. And if the fed becomes more cautious about cutting rates than markets expected, we could see disappointment in the market. And that will trigger a pullback in the stock market. We will keep an eye on this issue.